RMI 2302 Risk in Business Society Topic 1 Basics of Risk What is Risk Many Definitions o Individual o Organization o Society Uncertainty Regarding Loss Using the Term Risk o Which is riskier o Jumping off of a 1 story building o Jumping off of a 25 story building o What is a high risk driver o Danger Does not equal Risk Risk Measurement Terminology o Frequency Likelihood How Often o Severity Impact How Bad o Expected Value Loss Frequency x Severity o Risk Profile o A lot of uncertainty regarding the outcome of your driving o Risk Measurement Degree of Risk o Relative variation of actual from expected loss variation or standard deviation o How far is it from what we expected to happen to what actually happened Start Thinking about Risk o Uncertainty is doubt about our ability to predict future outcomes o Uncertainty can differ across individuals o Information does not alter risk objective but can alter uncertainty o Reduction in uncertainty can be a good thing even when risk is the same subjective o Core Risks involve what you do or what your business does o Secondary risks involve other risks that you take on in the process of doing your core objective Categories of Risk o Pure vs Speculative o Pure risk has either loss or no loss associated with it o Speculative risk can result in either no loss a loss or a gain o Static vs Dynamic o Static risks do not change through time o Dynamic risks change through time most risks are dynamic o Fundamental vs Particular o Fundamental risks affect everyone at the same time o Particular risks affect one person a few people at a time o Core vs Secondary Sources of Risk o Personal Risks o Property Risks o Health Final Exams o Cars clothes electronics home o Liability Risks o Financial Risks o Can you be held responsible for your actions car accidents o Return on Investment Portfolios Pensions Some More Risk Terminology person or property facing risk of loss the immediate cause of loss condition affecting the frequency or severity of loss o Exposure o Peril o Hazard Types of Hazards o Hazards conditions affecting perils frequency or severity of loss o Physical hazards property conditions o Intangible hazards attitudes or culture o Moral hazard behavioral changes o Morale hazard indifference o Societal hazards legal or cultural Attitude Toward Risk o Risk Neutral indifferent toward risk o Value of risky situation is expected loss o Risk Averse Prefer to avoid risk o Willing to pay more than expected loss to avoid risk o Risk Seeker prefer risk o Would pay more than expected return to engage in risky situation Burden of Risk on Society o Need for Larger Emergency Funds o Loss of Needed Goods and Services o Fear and Worry How Do We Handle Risk o Individuals o Prevent reduce save money for a rainy day o Organizations Entire Industry Risk Management o Strategic risk where will we be 5 years from now o Operational risk Prevent work related injuries o Society o Government has evacuation plans in the event of bombings natural disaster Definition of Risk Management o Scientific approach to dealing with risk Rules of Risk Management 1 Don t risk more than you can afford to lose 2 Don t risk a lot for a little 3 Consider the odds The Risk Management Process 6 STEPS 1 2 3 4 5 6 Determination of objectives Identification of risks Evaluation of risks Consideration of alternatives selection of the tool Implementing the decision Evaluation and review Step 6 Evaluation and Review program already in existence Evaluation and Review Generally o Reevaluate program s objectives o In theory the evaluation and review are the final step in the risk management process o Except in the rare case where an organization is newly created every organization will have a risk management o Repeat identification process to assure that it was performed correctly o Evaluate the risks that have been identified o Verify that the decision on how to address each risk was proper o Verify that the decision was property executed Step 1 Determination of objectives o There are a variety of tools available to assist in risk identification including questionnaires checklists and o The preferred approach to risk identification is a combination approach in which all of the tools available are Step 2 Identification of Risk procedure guides brought to bear on the problem o Inspections o Just as one picture is worth a thousand words one inspection tour may be worth a thousand checklists o An examination of the various operation sites of the firm and discussions with managers and workers will often bring attention to risks that might otherwise have been undetected o Analysis of Documents o Analysis of Financial Statements Dun and Bradstreet SEC 10 K Report Annual Report Balance Sheet Income Statement o Flow Charts Identify physical bottlenecks o Organization Charts Identify informational bottlenecks o Existing Policies o Loss Reports o Contracts and Leases o Interviews o Operations Managers o Chief Financial Officer o Legal Counsel o Plant Engineer o Purchasing Agent o Personnel Manager Step 3 Evaluate the Risk A Loss Frequency probability distributions B Loss Severity Maximum Possible Loss Probable Maximum Loss Use of Statistics Central Tendency Mean or Median Measures of Variation Law of Large Numbers Importance of Severity in Ranking Exposures o Actually there are two reasons that potential severity must be measured o Some notion of severity is necessary for classifying risks Whether an exposure will be classed as critical important or unimportant depends on the potential severity of loss o Severity must also be measured to determine the amount of insurance that should be purchased when the decision is made to transfer the risk Variance Calculation o Expected Value Probability x Value o Variance Loss Value E Loss 2 P Loss o Standard Deviation Square Root of Variance o Coefficient of Variation Standard Deviation E Loss Step 4 Consider Alternatives Risk Control o Avoiding losses has always been one of humanity s greatest concerns and risk control was undoubtedly the first risk management technique o Broadly defined risk control encompasses all techniques aimed at reducing the number of risks facing the organization or the amount of loss that can arise from these exposures o Risk control includes risk prevention and risk reduction Risk Prevention Reduction o Broadly speaking loss prevention efforts are aimed at preventing the occurrence of loss o In addition loss reduction efforts can be directed
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